International trade is a key driver in the demand for foreign currency as consumers and firms around the world need foreign currency to trade with one another. The globalisation of the marketplace in the last fifty years has intensified this demand and it was reported that by the early part of the 21st century over $1.5 trillion in national currencies was traded daily to support the expanded levels of worldwide trade. However in order to trade in this competitive environment firms must accept exposure to the risks associated with changes in currency. These risks can be great as foreign currency changes daily and directly impacts on the price and demand for goods and services.
Japan, for example, is a high exporter of consumer goods, in particular electronics and automobiles (cars), to countries like the US. In order for US consumers to purchase Japanese goods they generally have to purchase Japanese Yen with their US Dollars to make payment. As a result Japan’s trading position places them at risk to adverse changes in the short or long term movements of exchange rates. We call this Economic Exposure.
As the graph highlights the Yen has strengthened considerably, by 13.89%, in the last two years. In terms of a trading position this means that it costs US consumers more US$ to purchase Japanese goods. But why has this happened? This trend in Japanese currency strengthening has been apparent for a number of years and is due to the simple fact that more Japanese Yen is demanded than what is supplied. The primary reason behind this is that western consumers have continuously purchased cheap goods from Japan for over 20 years, demanding Japanese Yen as they do so. Furthermore the recent economic recession, the effects of which have been more profound in US and European economies, have meant investors have seen the Yen as a safer investment during times of uncertainty, causing it to appreciate in value. The question is whether this is a sustainable trend for the Japanese economy?
The simple answer would be a resounding NO based on recent announcements about the country's performance. Firstly Japan announced on the 25th January that 2011 saw the country’s first annual trade deficit in 30 years, with a deficit of 2.9 trillion Yen ($32bn, £20bn). This came as exports fell 2.7% and imports rose by 12%. The situation seems to have worsened further in recent weeks as it emerged exports in January were down 9.3% compared to 2011. Furthermore car manufacturers Honda and Toyota and electrical manufacturers Sony and Panasonic have all announced either slowing or declining 2011 profits since the new year. These companies are key contributors to the Japanese economy.
What will all this mean for Japanese manufacturers who export to places like the US? The problem for Japanese manufacturers is that their primary market lies overseas, in particular in the US and Europe. During the past few years of economic recession consumers have tightened their belts and spent less on imported goods from places like Japan. The currency strength has compounded this problem as not only do consumers have less to spend but it now costs them more to purchase their goods. This could mean that Japanese companies begin to locate their production facilities overseas to help mitigate the Economic Exposure they are experiencing at the moment. Toyota, for example, have recently announced that they are looking to expand exports from their US plant by 20% in 2012 to mitigate the problem caused by the strong Yen. Generally though I feel we are more likely to see Japanese manufacturers relocate within Asia to countries like China and Thailand or even stay in Japan. This is because Asia still holds a significant advantage over their western counterparts in terms of labour and production costs. The Yen and other Asian currencies would have to strengthen a colossal amount for manufacturers to begin to filter production back to the US and Europe.
Could the strong Yen benefit UK manufacturers? There have been a limited number of examples where UK manufacturing has strengthened due to companies avoiding the strong Yen. Japan based car manufacturer Nissan has a production plant at Washington, Sunderland which in 2011 experienced a 14% rise in production taking its output to 480,000 vehicles and created over 1,500 new jobs. This is a positive sign for the UK manufacturing industry and UK employment which is grateful for any positive news it can get. However, is this a genuine sign that Japan based manufacturers may look to the UK as a valid alternative? In reality Sunderland volume of output is just a drop in the ocean in comparison to Japan’s firms; in 2011 Honda produced 2.9m cars and market leader Toyota produced over 7m! I think a more logical explanation for the Sunderland figures is that this is an example of a growing worldwide company, Nissan, diversifying its operations to respond quickly to the market all across the world.
I think that overall the only outcome of the strengthening of the Japanese Yen will be a small change in the pricing of consumer goods exported from Japan. Consumers who have got used to cheap electronics may see a marginal increase in prices. A shift in the location of the production facilities, on the back of the Yen strength, quite simply is not on the cards. Lets face it; it seems ridiculous to describe the current exchange rate of $1/¥79 as strong anyway, so any radical change in the worldwide consumer goods market seems unlikely to say the least.
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